28 March, 2020

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Let Us All Be Keynesians & Fisherians To Face This Severe Medical Crisis

By Hema Senanayake

Hema Senanayake

We are in a mess, so think some economists. They say banks are solvent this time unlike the Great Recession in 2008-2009. During the Great Recession the crisis was complex requiring the government to bailout banks apart from major manufacturing companies. They further say that this time the problem is straight forward which is the containment of virus as banks are solvent. This notion is wrong.

We are in a full-blown crisis. It appears that it is predominantly a health crisis and a problem of broken production and supply chain globally. But the crisis is much deeper. Stock markets are crashing. Values of pension funds invested in stock markets are depreciating. Investors in Asia and Europe move their investment funds to Wall Street which would have resulted in creasing the Indexes at Wall Street under normal circumstances but this time around those Indexes kept plunging, almost 30% down. Global savings just evaporating through Wall Street!

Is the banking system resilient to face the stock market crashes world-wide? Are banks resilient to absorb shocks arising from credit defaults by businesses and consumers? What about the possible sovereign debt defaults by countries like Italy? Already, banks are not making loans. A few days ago, Boeing asked $60 billion from the U.S. Federal government. Watch what is happening in Goldman Sachs, perhaps you may gauge the level of resilience of banks from this single non-banking financial institution. I think, the U.S. president should make a concerted effort with other world leaders to close stock markets temporarily until the curve of the disease infection flattened.  

If the crisis is a mess, then it is going to be bigger and complex one which cannot be resolved by reduction of interest rates, Statutory Reserve Ratio and by another round of Quantitative Easing (a method of pumping money by the Central Bank). Paul Krugman, a Noble Prize-winning economist predicted that the world is drifting into a permanent recession. He might be right or wrong. But I think we must be prepared for the worst.

Still Trump did not say that he is a Keynesian now. But with his actions, he proved that he is a Keynesian. He got both Executive branch and the legislature intervened to manage demand and supply. Towards the end of the last week, President Trump invoked a special piece of Legislative Act known as Defense Production Act. Under the powers of this Act, he (administration) asked General Motors( a car manufacturer) to manufacture respirators, ask another manufacturer of pampers to produce medical grade masks and protective gowns for health care providers and asked alcohol beverage manufacturer to produce hand sanitizers and the list goes on. In fact, he is now a supper Keynesian. If the virus is contained successfully for which we earnestly hope, there will be excess production of certain products but that’s okay.  There is nothing wrong if global leaders act like Keynesians. But to enable them to function as Keynesians, they need to act as Fisherians too. This article is to originate a discussion about it. 

After the Great Depression in 1929-1933 the world learnt two lessons. One is provided by John Maynard Keynes in 1936. His General Theory evolved to dominate macroeconomics later with brief periods of setbacks. In a crisis like this suddenly all become Keynesians. The second lesson was provided in 1936 by Irving Fisher, a great American economist. He insisted that the economy must be founded upon Full Reserve Banking as the Fractional Reserve Banking might lead to create excessive debt bubbles which are bound to crash. He explained that the Great Depression was a direct outcome of Fractional Reserve Banking which is known as the debt-based monetary system.  Many economists agree that the Great Recession too resulted from the same debt-based monetary system.

It is true that the present obstruction of global production and supply chain and the resultant recession is not directly resulted from the debt-based monetary system.  Perhaps such recession could have been a few years away on the timeline. Yet suddenly the world is facing a medical crisis. I observe that Fisher’s proposition for the transition to Full Reserve Banking from present debt-based monetary system is applicable under the current crisis as the said transition could provide an opportunity to create a lot of debt-free money for governments to make their due response for the health crisis without creating any inflation. 

What are the risks of such transition? A few leading economists using mathematical models tried to answer this question in recent times. Using Dynamic Stochastic General Equilibrium (DSGE) models, they have proved that the transition to Full Reserve Banking can be done smoothly. So should be the reversal of it, I think. Japanese economist Prof. Kaoru Yamaguchi is a leading economist who have studied this subject extensively after the Great Recession. Also, in 2012 International Monetary Fund published a Working Paper in which it insisted that above mentioned transition can be done smoothly. Research object of those studies was the U.S. economy.

If the methodology is simplified, the Central Bank would increase the Statutory Reserve Ratio gradually to 100%. As a result, commercial banks will begin to function as intermediaries making loans without being able to create “credit-money”, a virtual money in the system. Hence, the virtual money formerly created by the commercial banks under Fractional Reserve Banking, would be created under a Public Money Policy by the Central Bank now. I think, the plan could be implemented partially and might be reversed gradually when more flexibility is required for the economy, (as new piece of theory does not support for permanent transition to Full Reserve Banking system). Obviously, for those countries which use some other country’s domestic currency as their reserve currency for international payments, this plan could be a prudent plan. 

However, for those countries which hold global reserve currencies, like dollar and euro, this plan could be implemented partially so that those countries would create a lot of debt-free money to be used domestically or within the monetary union and to support the rest of the countries while keeping enough flexibility to serve the world as reserve currencies.

Still American politicians are arguing about finding money. New York Mayor demanded money from the federal government saying that many New Yorkers would die who are not supposed to die if federal government does not act swiftly. Federal government was not quick to pass the stimulus Act which will provide money directly to households, hospitals, cities, local and state governments. This happens, because federal government thinks how much it should be indebted more, they do not think in terms of Fisher’s proposition, a method to create debt-free money. If physical capacity of production to face the health crisis is available or could be made available sooner, money should not be a limited resource. This is an exact time even the U.S. government must explore the possibility of switching from debt-based monetary system to a partial “full reserve banking” system. By definition there is no partial full reserve system, but here partial full reserve banking system is a system in which commercial banks create a lessor amount of “credit money” while the government creates a good amount of debt-free money under a Public Money Policy, not exceeding the system’s requirement.

Let us all be Keynesians and Fisherians to face this severe medical crisis.

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Latest comments

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    We are in a full-blown crisis, The virus is teching :What are the lessons for other countries?

    All Set guidance is subject to change as information emerges on transmissibility and changing the world pattern. World is at best in different direction and in new solution.

    Healthy habits
    Think some economists, monetary system
    Work can be per­formed from home
    Transport stepped up the cleaning regime

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    It became crisis for some countries, it is a puzzle to me, jusr neglecting what was happening in China. I think they thought, that is to be China’s problem. It looks they did not care about Iran too. When it came to Italy and Spain, that is part of Europe Union. Yet, they thought “NO it is not in our territory.
    USA, though neglected it, now talk of Trillions of Dollars worth bail out packages.
    Sri Lanka and even India, is suffering because of Tourism They need money at any cost, is it worth or they need to rethink the strategy again. Is it only the COVID-19 that ruin or may ruin the country. Sri Lanka is handling it well, an this is going to be there for sometime and Sri Lanka need to think about the follow up strategy after the 14 day period. I think, France is taking steps only to check the most vulnerable. That includes elderly. Sri Lanka also has to check what strains are there, particularly, Italian strain seems more fatal.
    Covid-19 harms Sri Lanka economically, but it is not an industrial or mostly exporting economy. Just import and consume. Importing cars, fossil fuels and vehicle parts affect the economy more. That is in addition to need more road construction, more accident deaths and maimed bodies and fumes cause cancers whih needs more cancer wards.

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    Yes, this “Full, yet Partial Reserve System” sounds the perfect solution. That’s what the US and the West were aiming for actually…..ok, they could have moved faster with it. But China (with the help of Russia), has created a full partial system, with 100% virtual-ness, in the vain-glorious attempt at global domination.

    I mean, just look at how the Chinese developed their capitalism. They blatantly followed the former Western model, destroying their environment, building concrete structure upon concrete structure, and even building a Chinese city in Lankan harbor area.

    For the sake of Sri Lanka at least, we cannot use tribal anger to put past historical events in present context. US and West did what they did solely because they had guns at that time. But they have seen the error of their ways, and now they have knowledge far ahead of all others. Their universities and institutions are full of critical thinkers, that know the value of environmental and global sustenance. But places like China and Russia just do not have that democratic institution to put democratic critical thinking in place. Destruction of the perceived enemy by them has no checks and balances.

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      Correction: But China (with the help of Russia), has created a system without much reserves, with 100% virtual-ness, in the vain-glorious attempt at global domination.

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    For the last few decades, this PLANET has gone through immense challenges to its very existence and survival. Like in a human body, which has a very strong system called “IMMUNE SYSTEM” that “RECOGNIZES”, “MOBLISES” and “ATTACK” to “PROTECT” and “SAVE” life from extinction, this planet “EARTH” also has a similar “PROTECTIVE SYSTEM” to do the same function needed by the human body. I call upon, some qualified person out there to analyze that “immune system” in the physical body, as to its presence, what it does and how it functions. In simple terms to my understanding is, that system defines “Who am I?. In short, it distinguishes” Self from Non-Self”. This “Non-Self” is all that “Invade” us from “Outside”. If our “Immune System” is not strong and capable of doing the three functions, I stated above, there is no protection and saving the body from death. That is how all the “Plagues”; “Viruses” attack us. I am of opinion, the same “Attack” is taking place on the planet EARTH. For that the “Scientists”, (of all sorts)”Technologists” (of all categories), “Indistralists” (of varying fields) “Economists” (of scales) and not but the last the “HUMANS”, have to collectively take a considered “HARD LOOK” and “RE-ASSES” of what has gone “WRONG” for these “CATASTROPHES” to take place. I feel, the “Immune System” of this planet is “TAXED” and “CHALLENGED” in the name of “PROSPERITY” backed with “GREED” (of all types) and unless that system is not strengthened to “Recognize”, “Muster” and “Attack”, we would be on a fast track to “DEATH”. That, “RE-ASSESSMENT” of all our activities is the NEED of TODAY and NOW.

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    Another explosion of a disease ridden situation in the slow manner our refuse and other waste is been rid off will occur sooner than later. In the main cities , the municipalities seem to have suspended the removal of waste from households, and no signs of the collectors. Moreover, the recent reports of raping and looting of forests and illicit and illegal removal of species has been going on for some time , and in certain instances under the very nose of the protector. These precious gifts of nature should be protected and violators severely punished. Politics should stay out, as they have been the worst. To neglect and ignore these warnking would be to our peril.

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    hmm brainy

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    As far as the United States is concerned, it operates a pernicious variant of capitalism: all for the upper 1% and almost nothing for the bottom 99% in terms of rewards. Note the increasing income and wealth inequality, declining intergenerational mobility, mounting economic and social polarization, and rising influence of wealth in politics. This had led to the concentration of both economic and political power in the hands of the elite 1%. The true face of perniciousness is easily evident in the broken healthcare system of the US. More than 80 million American do not have medical insurance or are under-insured. They cannot go to a doctor without risking bankruptcy. That partly explains the current situation of the pandemic in the US. Further, the richest country in the world has the worst medical infrastructure to deal with a pandemic. Check out what is happening in New York. Even without the pandemic, the US was heading for a recession. Some people have to work 2-3 jobs to make ends meet. Thus the US situation is a very complex one needing major overhaul. I hope that the Corona Virus will jolt US society to fundamentally alter its social and economic fabric. In other words, piecemeal remedies like banking sector reforms (which this article refers to) are only a cog in the complex wheel of US socio-economic development.

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    One is left to wonder about the timing of this article, even if one may have some sympathy for the Fisherian approach. In the next 6-12 months (if not more), there are 2 issues of immediate concern: 1) stop the pandemic and 2) provide support to the populations displaced by crumbling enterprises (sectors). What banking systems to operate to take care of these issues may be of marginal relevance.
    As far as the United States is concerned, it operates a pernicious variant of capitalism: all for the upper 1% and almost nothing for the bottom 99% in terms of rewards. Note the increasing income and wealth inequality, declining intergenerational mobility, mounting economic and social polarization, and rising influence of wealth in politics. This had led to the concentration of both economic and political power in the hands of the elite 1%. The true face of perniciousness is easily evident in the broken healthcare system of the US. More than 80 million American do not have medical insurance or are under-insured. They cannot go to a doctor without risking bankruptcy. That partly explains the current situation of the pandemic in the US. Further, the richest country in the world has the worst medical infrastructure to deal with a pandemic. Check out what is happening in New York. Even without the pandemic, the US was heading for a recession. Some people have to work 2-3 jobs to make ends meet. Thus the US situation is a very complex one needing major overhaul. I hope that the Corona Virus will jolt US society to fundamentally alter its social and economic fabric. In other words, piecemeal remedies like banking sector reforms (which this article refers to) are only a cog in the complex wheel of US socio-economic development.

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